The Bottom-line Benefits of Cost Transparency

Everlane is one of several fashion startups taking a bold leap beyond just talking about openness as a core value. The San Francisco-based e-merchant backs up its claim of “radical transparency” by displaying a detailed breakdown of the variable production costs for every item on its website.

On its face, the decision to share those numbers with consumers seems risky. Customers might, for instance, object to a company’s profit margins or to the way it allocates costs. A surprising new study by Harvard Business School researchers Bhavya Mohan, Ryan Buell, and Leslie John suggests that these risks may be far less significant than the rewards of open communication with customers.

In “Lifting the Veil: The Benefits of Cost Transparency,” the authors present evidence from the lab and the field that brands can increase their allure and their sales potential by explaining some of the key expenses that factor into a product’s price tag.

Lifting the veil

Participants in the lab experiments viewed one of several versions of a product detail page for a T-shirt on a simulated website and then rated their purchase intentions and the attractive qualities of the brand on a scale of 1 to 7. Each of the pages, except for one used as the control, incorporated an infographic that showed the components of the production process (i.e., cotton, cutting, sewing, dyeing, finishing and transportation), their total cost, or the cost of each one.

Statistical analysis of these data confirmed the potential bottom-line benefits of the high level of cost transparency practiced by companies like Everlane. The page that specified how much each part of the production process cost significantly increased participants’ attraction to the brand, which in turn, increased their willingness to buy. Proprietary information that was less sensitive and deeply revealing, such as the total production cost, had no impact on participants’ purchase intentions.

“When the total cost is shown in isolation from the production process,” says Mohan, “it’s probably not particularly meaningful to consumers. In contrast, a depiction of how much a brand spends on each activity in a long production chain not only sheds a lot of light on the brand’s inner workings, but also draws consumers’ attention to how much effort goes into making its products.” Consumers may be more likely to see that brand as refreshingly forthcoming and to regard its prices as reasonable.

Power of self-disclosure

The authors’ results also suggest that consumers appreciate an inside look at a brand, even when they don’t particularly like everything they see. For instance, people often view spending money on something they can’t see or touch as wasteful, and the researchers’ test subjects confirmed this bias by indicating that the cotton for the T-shirt should cost the most, and transportation, the least. Yet an infographic that revealed $.50 was spent on cotton and $2.75 on transport strengthened brand attraction and purchase intentions as much as one in which these allocations were reversed. This counterintuitive finding attests to the power of self-disclosure to enhance likeability. Brands that reveal hidden angles of their business may boost their likability quotient enough to overcome negative preconceptions.

The study revealed a surprising degree of tolerance, even for high profit margins.

In fact, Mohan and her colleagues found a surprising degree of tolerance even for exceptionally high profit margins. When the researchers set production costs at $6.70 and assessed participants’ willingness to buy at prices ranging from $10 to $100, the benefit of cost transparency weakened as the price rose, but it continued to exert a positive effect until the price reached $40. “What was even more striking,” says Mohan, “is that cost transparency didn’t significantly reduce willingness to buy even above the $40 mark.”

Only when the product page explicitly stated that the company’s markup was 4.3 times the cost and that its competitor’s markup was only 3.5, did cost transparency hurt brand attraction and purchase intentions. It seems that cost transparency becomes a liability only when a company goes out of its way to emphasize information that’s bound to rub consumers the wrong way.

The authors also tested how cost transparency played out in the real world with a field study at an online retailer. In an effort to boost sales of a high-end wallet during a post-holiday slump, the company parsed the price on its website. The $115 wallet came in five colors and cost $58.50 to produce. An infographic showing how these costs broke down was supposed to be displayed on each of the product pages for the five color options. However, the company inadvertently neglected to place the infographic on the pages for two of the colors and didn’t rectify the error until five weeks later. By comparing the difference between the sales of these two colors and sales of the other three before introducing the infographic to the difference after its introduction, the authors obtained a concrete measure of cost transparency’s financial value: the increase in daily unit sales for each color amounted to a whopping 44%.

Mohan cautions that cost transparency may not be the best way to go for every retailer. For example, those whose cost structure is a competitive advantage or whose suppliers require that their prices be kept confidential may find this strategy unworkable. Others, including merchandisers that rely on a lot of different manufacturers for their goods, may simply lack access to the necessary information.

“The approach used in our study could also be problematic for industries with high fixed costs such as overhead and research and development,” Mohan says. Pharmaceutical manufacturers are a case in point. “An infographic showing that a $100 pill cost a penny to make is apt to outrage consumers because it doesn’t reflect the multi-million-dollar R&D investment and huge financial risk involved in bringing new drugs to market. In cases like this, the firm may want to consider disclosing its fixed expenses.” At least one company, a social media service, has already taken that step, including the percentage of a customer’s payment that goes toward employees’ salaries in its price breakdown.

Strategy for young brands

“Overall, our findings suggest that cost transparency offers brands an innovative, inexpensive way to increase brand magnetism and sales,” says Mohan. “It’s a particularly great strategy for young companies that need to raise their profile and build strong customer relationships without the benefit of an established brand or big-budget marketing programs.”

The authors acknowledge that some of the power of this strategy may lie in its novelty. Right now only a handful of retailers disclose their productions costs. A brand that does this won’t look quite as special if all its competitors start doing it too.

Looking at the broader implications of their research, the authors see a major competitive advantage for brands that step up their efforts to get real with their customers. “When the participants in our study were allowed to look beneath the shiny surface of the brand, they rated it as more friendly, helpful, kind, and likable,” says Mohan. “These are the personality traits of a brand that consumers want to engage with and advocate for and that seems worthy of their trust and loyalty.” Even when the brand reveals a few flaws, they value its honesty and authenticity.